Primary Corporate Bond Markets and Social Responsibility

The increasing importance of corporate objectives beyond narrowly defined profit maximization has arguably been one of the most fundamental trends in financial markets over recent years. Environmental and social objectives (we explicitly exclude governance aspects from our analysis), denoted as ES, are now explicitly recognized by a large number of asset managers and institutional investors and by a fast-growing number of CEOs. At the center of the debate surrounding these developments is the question of how such broader objectives affect financial asset prices and in particular risk premia. Especially for equity markets, there is now a large academic literature that analyzes the connection between ESG objectives (i.e., objectives with respect to the Environment, Social aspects, and corporate Governance) and equity returns. We present the first comprehensive analysis of the effects of different ES dimensions on corporate bond issue spreads, covering a large sample of U.S. issues from 2002 to 2020.

Theoretically, as shown in Heinkel, Kraus and Zechner (2001), high ES stocks (i.e., responsible firms) are valued more highly and come with lower expected returns if a subset of investors have ES preferences. The opposite is true for stocks of low ES rated firms. Intuitively, this result arises because fewer investors are willing to hold low ES rated firms and, thus, risk sharing among those fewer investors is imperfect. Subsequent theoretical work shows that this general result may not always hold in settings where some investors do not fully account for the relation between ES scores and the distribution of future corporate cash flows or where investors’ ES preferences change over time. Essentially, unanticipated increases in ES preferences, or unanticipated improvements of future cash-flow distributions of high ES firms, may lead to further appreciation of such stocks, thus providing higher returns to investors already following an ES strategy.

Empirically, the effects of ES investor preferences on equity risk premia are therefore difficult to document, since expected risk premia are not directly observable. By contrast, bond markets have the potential to provide a much cleaner setting to measure these relations. Primary bond markets represent a setting, in which expected risk premia can be quantified via observed spreads over a riskless reference rate. Primary markets have the additional advantage that offering prices are usually intermediated by investment banks, which should ensure that corporate bonds can be issued at a fair spread which is less likely to be influenced by temporary  market (il)liquidity levels, which is often times the case in secondary bond markets. At the issue stage, bonds generally also have a recent credit risk rating, which effectively controls for many issuer and bond characteristics.

We document several major results in our empirical analysis. Most importantly, we find a robust negative relation between ES ratings and issue spreads in the corporate bond primary market. Thus, primary bond markets reward firms for good ES performance, even when controlling for bond ratings and various firm characteristics, such as net book leverage, size, profitability, tangibility, dividend status, experience as a bond issuer, and industry and time dummies.

However, the relation between ES and issue spreads is much more nuanced than this general finding may lead us to suspect. When using more granular scores, we find that the negative association between ES ratings and issue spreads is largely driven by product-related dimensions of ES-scores. This seems plausible, given that these are most closely related to value creation within firms. Other dimensions such as environment, community, or human rights, that get more attention in the media and by policy makers, however, do not seem to matter for the pricing of corporate bonds.

Furthermore, we find substantial variation over the business cycle. While good scores in product-related dimensions always help reduce spreads, a high score on employee relations has a significantly negative effect on spreads in the primary market only during expansions. Thus, firms with high scores on employee relations seem to have a comparative advantage in expansions, which are usually characterized by tighter labor markets. During recessions, we also find – rather surprisingly – marginally significant positive signs on environment, community, and human rights, meaning that issuers scoring high on these dimensions are penalized by higher bond spreads.

We find that the results vary across different rating classes. The negative relation between a good aggregate ES score and issue spreads is only significant for bonds rated BBB or below and for those that do not have a rating. For highly rated issuers (i.e. AAA or AA) the aggregate ES score is insignificant. Given that the effects of ES ratings on spreads are predominantly driven by lower-quality issuers, this suggests that the spread-reducing effects may be risk-induced, i.e. ES performance may be considered to lower credit risk. However, if bond payoffs are less correlated among lower rated bonds, pure demand effects due to investors’ preferences for sustainable investments are also consistent with this empirical result.

Finally, when analyzing the cross-section of industries, we find that ES scores matter for industries including agriculture, forestry, fishing, mining, construction and manufacturing. Most interestingly, the environment-related sub-score that has not played a significant role in the empirical results up to this point shows a significantly negative and economically substantial impact on spreads for firms that are particularly exposed to environmental risks (e.g., agriculture, mining).

To conclude, our results draw a much more nuanced picture of the impact of ES scores on risk premia, in particular bond spreads in primary markets, than the literature on sustainable investing. Importantly, we find that dimensions that are clearly related to firms’ value creation – i.e., product-related and employee-related dimensions – matter most consistently. We also highlight that aggregate ES ratings might be too crude measures of firms’ social responsibility and that we must consider the different components of these ratings to better understand which aspects of ES are rewarded, punished, or ignored by financial markets.

Michael Halling is Associate Professor in Finance at the Stockholm School of Economics and Research Fellow at the Swedish House of Finance (

Jin Yu is Associate Professor in Finance at the Department of Banking and Finance, Monash University (

Josef Zechner is Professor in Finance and the Vienna University of Economics and Business (



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